Article by Peter Gravestock, published in the August 2002 issue of Tax Adviser. Peter Gravestock is a Past President of the ATT and Past Chairman of its Technical Committee.
The new system of Tax Credits scheduled for introduction from April 2003 contains a myriad of anomalies and complexities which are unlikely to be understood by the average individual who would be a potential beneficiary.
Working rules for the new system are in a statutory instrument which provides for calculation of a claimants income by rules which are similar to the computation of total income for tax purposes but with some crucial differences. This will inevitably result in tax advisers being asked to assist with these claims which raises some concern in that advisers dealing with tax returns could be vulnerable to indemnity claims if they do not spontaneously recognise claim situations and prompt the client to make a claim.
Concern about the practical application of the arcane rules in the draft statutory instrument issued last May has resulted in a letter from the Association to the Inland Revenue to seek clarification of computation requirements. That letter is reproduced here and highlights in a self explanatory manner the particular areas of concern in attempting to make this new system workable:
“The Association of Taxation Technicians welcomes the opportunity to comment on the Draft Statutory Instruments issued 9th May 2002. Our comments are restricted as the drafts do not give all of the information that is needed for a full and complete understanding of the practical implications of the new Tax Credit rules. It is appreciated that it will be necessary for the Tax Credit Bill to become law before certain areas are finalised, but it would be useful to have more information particularly relating to deadlines at this early stage.
The Association is also concerned about the practical difficulties of using different definitions for Income Tax and for Tax Credits and by the erosion of independent taxation. Whilst it is understood that anti-avoidance legislation is necessary it must, in our view, be formulated in a manner capable of practical implementation by tax payers.
The Tax Credits (Definition and Calculation of Income) Regulations
In the Budget press releases reference is made to income as being for income tax purposes whereas the draft SI does not follow that approach. Every difference will create complications in administering the system as well as causing confusion for claimants.
It is noted at Para 3 (5) that the £300 of certain income may be disregarded. As this only applies if that income does not exceed £300 there will be a charge of £111 (£300 x 37%) on the extra £1 of income received. It would be better if this provision applied the same principle as the disregard of £2500 of income increase.
It is not immediately apparent whether Para 4 (2) (a) would include income chargeable under Finance Act 2000 Schedule 12 Para 2 (1) (Personal Services through an Intermediary). Presumably the intention is that it will be caught, in which case the definition of Dividends in Para 9 (2) (e) should be reduced by a claim made under Finance Act 2000 Schedule 12 Para 13 to avoid double counting.
The notes refer to certain benefits e.g. vouchers for registered child-care not being included within the definition of employment income. The eventual notes will need to specify very clearly what benefits are not included. It should be noted that any benefits chargeable to income tax but not included for tax credits will lead to manipulation of the Tax Credit legislation. The exclusion is not consistent with the concept of simplicity and items should not be excluded on those grounds (Point 13 of Memorandum).
The table in Para 4 gives certain deductions but does not appear to give deductions for expenses deductible under TA 1988 s201 (Subscriptions to Professional Bodies, etc.) or 201AA (Employee Liabilities and Indemnity Insurance) or to 201A (Expenses of Entertainers). It is noted that relief is given for GAYE deductions whereas no relief is given for similar amounts paid by Gift Aid.
In Para 5 the requirement is to include net profit derived in a tax year. It is noted that amendments are being made to the Tax Credits Bill to alter the definition to current year basis. It is suggested that this definition should also be altered and should be brought into line with the Schedule D Case 1 definition of current year basis i.e. the accounts ending within the tax year. This will remove a number of practical difficulties of timing.
The wording in Table 2 at 9 refers to “The amount of any capital allowances available in that year..”. This would infer that if there have been any restrictions of first year allowance or writing down allowances then the allowances to be deducted would be those that could have been claimed i.e. those available. Please confirm that the deduction should be for allowances actually claimed in the year.
It is also noted at Para 10 that the excess of any VAT paid in the year over VAT received in the year is deductible. As VAT is accounted for one month after the end of the VAT quarter this would give an impossible adjustment to the income. The amounts should refer to VAT payable (or receivable) deductible for Schedule D purposes relating to the accounting period. It should be noted because of the difference in the VAT legislation it is technically possible for there to be VAT paid that would not be allowable as a deduction for income tax e.g. payment of output tax based upon the VAT Fuel Scale Charge.
In Para 9 (2) (e) no reference is made to the addition of tax credits to dividend income. Also it is noted that regulation 19 refers to miscellaneous income whereas in the formula in Para 3 miscellaneous income is not included.
Whilst it is understood that there is a need to have anti-avoidance provisions, we would comment that at Para 14 the wording is extremely wide and in practice would be very difficult to use. For example if a sole director of a company decides not to declare a dividend (and the director and spouse own the company 100%) would this be construed as depriving the claimant of income? Clearly a company needs to retain reserves for the purposes of its business, therefore there must be some very clear guidelines issued as to when this paragraph could possibly be used.
Para 16 is totally unacceptable. Why should a person over 60 claim their pension rights? This is totally against government policy of encouraging people to work longer and to provide adequately for their retirement. At the very minimum the age should be 65. It should be kept in mind that personal pensions can be drawn from 50. The paragraph does not make it clear how this would apply if the policy has been written to a later age, e.g. 70, where there would be penalties for early encashment. Furthermore it should be noted that this legislation could be easily circumvented by those who wish to claim tax benefits and will only catch the uninitiated.
Para 18 is similarly difficult. It only refers to employment and not to persons providing services as a self-employed person. Furthermore the reference is to those paid for comparable employment, this is totally subjective and could only be operated where the amount is so totally unreasonable as to be outside the grounds of possibility. Furthermore this rule can only be operated by the Board as they are the only people who will have the means of determining whether the recipient has sufficient funds. It is not clear how any question could be worded on a claim form that would require a person to declare such provision of services as they would not be aware of the ability of the recipient to pay. Moreover, the legislation as drafted does not include a motive test, therefore its import is too broad ranging.
Para 19 includes miscellaneous income chargeable under Schedule D Case VI. This will include chargeable event gains. Because it is quite proper that a person will be claiming child tax credit whilst a higher rate taxpayer it is suggested that this legislation should be amended to only include the appropriate fraction of chargeable event gains where relief is claimed under TA 1988 Section 550 (Top Slicing Relief).
The new Pensions legislation encouraged people to take personal pensions when they do not have net relevant earnings. Consequently it appears to be contradictory to that principle that the only deductions that can be made for pension payments are against employment income or self-employment income. To maintain the spirit of the Pensions legislation surely the deduction for personal pension should be against any income. Following the same principle, relief should be given for Gift Aid payments.
It is not immediately obvious from the legislation or draft SI’s whether claims are made on a weekly basis or an annual basis. It would appear that the claim is based on a weekly amount whereas the annual adjustment is based upon annual income (and entitlement to claim). It would therefore appear that unless a child is born on the 6th April in a fiscal year that the enhanced family element of CTC will be spread over two fiscal years. This will reduce the maximum level of income at which a claim can be made to below the £66,000 expressed by the Chancellor in his Budget speech.
It is quite clear that claims for CTC must be made by 6th April 2003 whereas a similar claim for Children’s Tax Credit for 2002/03 could be made until 31st January 2009. We expect that there will be widespread publicity. However, we suggest that there will be a significant number of people who fail to realise the change in the time limits. It is suggested that a more relaxed time limit should apply at least in the early days.
Because a claim has to be made in advance it will be very difficult for claimants where their income drops. This will be particularly the case for the self-employed where it may not be apparent that their income has dropped until after accounts for the relevant period have been prepared. For example a claimants joint income for the year 2001/02 could be £60,000. Even with a qualifying child they would not be eligible for CTC in 2003/04. When accounts are prepared for the year to 31st March 2004 it may be apparent that the claimants joint income for that year is £48,000 and thus full entitlement to CTC arose. It is suggested that the latest date for claim for the family element of CTC should be no earlier than 31st January following the end of the year i.e. for 2003/04 31st January 2005. In practice it is suggested that three months should be allowed beyond that date. Even an employed couple may not know that their expected bonus will not materialise until late into a fiscal year and may therefore not be able to claim within the fiscal year let alone be able to claim before the commencement of the year.
In the same way it is possible that a large bad debt could occur at the end of the financial accounting period thus giving entitlement to Working Tax Credit as well as CTC. Again this will not be known until it is apparent that the debt will not be paid. This could well be some considerable time after the end of the financial year. For those reasons the Association would suggest a latest claim date for all purposes of 31st January following the end of the fiscal year in which there is an entitlement.
The Association also has concerns about the practicality of using the preceding year as the base year. For example a claim form for 2004/05 will be sent out in March 2004. This will be completed based upon the joint income of 2003/04. Even for an employed person this cannot be completed until after form P11d is received for which the relevant date is 5th July2004. It is suggested that the earliest possible date on which claimants could reasonably be expected to file income would be 30th September 2004. The forms then have to be processed with any underpayment for 2003/04 calculated. By this time some 8/9 months of the year 2004/05 will already have passed. There will therefore be the problem of the overpayment for 2003/04 and also overpayment for 2004/05, which will have been paid, based upon the 2001/02 year at this time. Clearly it will not be possible in many instances to reflect these changes in the remaining period of payment for 2004/05. A more practicable solution would be to base the claim initially on the income of the pre-preceding year i.e. 2002/03 for 2004/05 and so on for subsequent years. Again this can be corrected to actual. It is suggested that if this method was adopted the return for 2002/03 could be made by 31st January 2004 to form the basis of 2004/05 benefits payment. When the return for 2003/04 is made by January 2005 any overpayment could then be collected over the fiscal year 2005/06.
We would further suggest that if the definition of income is brought into line with income tax that the Revenue could be empowered to undertake the calculation based upon the filed tax returns thus simplifying the claim form to a mere document requiring the signatures of both claimants to confirm that self-assessment returns have been submitted by both. This would prevent unnecessary duplication of work for the taxpayer, for the agent and, it is suggested, for the Inland Revenue.
Tax Credits are intended for low earners and those of limited means. It must be appreciated that with a recovery rate of 37% fairly modest increases in income can result in large underpayments. If this also coincides with the elimination of claims for tax credits this could give rise to very large underpayments. For example if a couples joint income increased by £5500 compared with base year then excluding the disregard of £2500 the recovery would be £3000 x 37% = £1110. It cannot be expected that taxpayers/claimants of this category would be able to produce that sort of money within 30 days. This is particularly the case when they have no indication prior to receiving the bill that large amounts of money were owing and have no control over the timing of the bill. It is suggested that a structured method of payment either monthly or by addition to the half yearly payments on account for the self-employed with the first collection never being less than two months before the date of notification would give a better chance of the claimant being able to repay the amounts demanded, and avoid creating the child poverty which the legislation is intended to address.
Finally the Association would point out that the experience of their members is that taxpayers expect agents to complete many forms other than Tax Returns. For example most agents completed Further Education Grant forms for their self-employed clients. Accordingly it is strongly recommended that the Revenue deal directly with agents and that the forms 64-8 are used to facilitate authority.
The Association hopes that the points set out above will be useful in drafting the final legislation. Furthermore it is to be hoped that there will be a Code of Practice from the Revenue as to the practical administration of the Tax Credit legislation. We would be pleased to attend a meeting to expand on these problematic points or any other practicalities which you would like to discuss.”
ATT Technical Committee would welcome any input from members on these new rules to incorporate in continuing dialogue with the Inland Revenue.
020 7235 9381
August 2002 by